Structured Products – Alternative Avenue of Investment

Looking at the current market scenario, most people deal with high volatility and uncertainty, and many hesitate to invest even if they may be willing to do so for fear of losing their capital.

Structured products have been a successful avenue for many under such circumstances, providing not only on an efficient mode of investment but also have tailored capital protection option.

What are structured products?

Structured products are customized investment products to create wealth by investing in the market

They are market-linked debentures where a major portion of the money is invested in fixed income instruments and the remaining part is invested in derivatives of another underlying asset such as NIFTY, equities or currency.

For example, if you invest Rs. 1000 in such a product. About Rs.800 will be invested in debt instruments. The remaining Rs. 200 will be invested in NIFTY derivatives or other such products. The return on Rs. 800 will be around 6%-8% but will remain mostly fixed. The return on the other Rs. 200 will depend on the performance of the underlying assets.

Most structured products invest in such a manner that the principal is protected. (but the risk in Debt part should be understood)

Protecting the principal amount. Some offer only capital appreciation.

The product design and investment strategy are structured such that the product is able to meet the desired goals.

Who issues structured products?

What is the portfolio of a structured product?

It mainly comprises of fixed income products and derivative products. Many products on offer in India invest in NIFTY and NIFTY based instruments.

How much returns can be expected in them?

No company offers guaranteed returns as they are based on the performance of the underlying assets. The returns can lie between 0%-20% CAGR (ya ZERO if it’s capital protection) but can be more depending on performance and scenario.

What will be the tax liability of the investor?

The tax liability will be similar to any listed product. The sale of listed security held for 12 months or more attracts long-term capital gains tax. (normally the company buy the instrument before maturity for this) Some of the products pay an interest rate and that will be taxed as per the income tax slab applicable to the investor.

What risks should an investor consider while investing in them?

Liquidity risk as though these products are listed, they are not traded actively

Credit risk – If the issuer defaults on payment, you lose your investment and notional gains. (NBFC are right now famous for wrong reasons)

Market risk – If the product is invested in the market or other underlying assets that have price fluctuations, the returns on that extent of the investment depends on the performance of the underlying assets.

Event risks – National and foreign events such as elections, disasters, economic performance can affect the returns.

High Investment costs – The costs of the investment is sometimes unclear which can lead to high costs.

There is a max coupon rate targetted for each product (debt and equity) based on the NIFTY level provided the investor remains invested for the entire duration.

The duration of investment is around three years.

For example, a product that Anand Rathi offers is the Protected Call wherein the entire investment is done in fixed instruments and NIFTY put options are sold and the money received from selling the put options is again invested in NIFTY. Then depending on NIFTY performance, the returns vary. If NIFTY performs as expected, returns are the fixed coupon rate and if NIFTY does not perform as expected, there will be a loss on the put options but the investment in fixed instruments is as-is and the returns are protected.

Who should invest in structured products?

These products cater to HNIs as the ticket size is big. People who are able to invest such a big sum for the long term can take advantage of these products. It is suitable for investors who seek alternate investment products. Investors can participate in the derivative market using the professional expertise of wealth managers as the derivative market is complex.

How is it different from an equity mutual fund or a debt mutual fund?

Equity mutual funds usually invest a majority of the investment in equity and equity-based products. The risk is higher as there are not any capital protection guarantees. Debt mutual funds invest in debt instruments and the returns are limited.

Structured products allow you to take advantage of debt instruments and derivative markets that allow for some protection and a lot of upsides. They offer alternate avenues of investment for those who have already have allocated the requisite amount in equity and debt mutual funds in their portfolio.

Structured products offer new avenues of investment for the retail investor who has a high net worth. It is worthwhile to understand these products and invest once you have understood them clearly and think that it will diversify your portfolio and has the potential to improve your portfolio returns. At the same time, be aware of the risks and costs involved.

Hemant Beniwal is a CERTIFIED FINANCIAL PLANNER and his Company Ark Primary Advisors Pvt Ltd is registered as an Investment Adviser with SEBI. Hemant is also a member of the Financial Planning Association, U.S.A and registered as a life planner with Kinder Institute of Life Planning, U.S.A.
He started his Financial Planning Practice & TFL Guide Blog in 2009. "The Financial Literates" is a dream & mission to make Indians Financial Literate.